Of course, there is no free lunch with index annuities. Investors, who may only earn a participation rate of, say, 60% to 70% of the upside performance of an index, give away the upside of stocks in a bull market. There might be an interest rate "cap," limiting how high a client's interest rate can go. Or there may be a "margin," "spread" or "administrative fee" subtracted from the index.

Sometimes, the percentages, caps or margins can change during the contract term.

The annuity return also excludes the reinvestment of dividends. Like other annuity products, this type of annuity comes with back-end surrender charges that can be over more than ten years. In addition, most state guaranty associations cover up to $100,000 of a fixed annuity in the event the insurance company goes belly-up.

So it's best to diversify your clients' equity index annuities with a number of carriers. An investment in an equity-index annuity is tax-deferred. At maturity, the policyholder can cash out and pay income taxes on earnings, or opt to receive periodic payments for life. Withdrawing from any type of tax-deferred annuity before age 59½ means a policyholder could face a 10% IRS fine.

David Maurice, a partner in the financial planning firm Carrier and Maurice, Johnson City, Tenn., does not recommend index annuities because of surrender charges, complexity and the fact that ordinary income tax is charged on the earnings. It is hard for investors to compare index annuities and estimate their expected returns due to complex formulas used to calculate returns.

"We think [index annuities] are flawed by design," Maurice says. "I can get better returns with less risk by diversifying clients in a wide range of assets classes over the long term."

Jerry Miccolis, financial planner with Brinton Eaton, Madison, N.J., agrees. He diversifies client investments based on their future cash flow needs, life expectancy and legacy needs. He puts conservative clients who need every penny to live on over their lifetimes into diversified portfolios of individual bonds and stocks. He protects all of his clients against severe stock market losses by investing in a structured note developed by Deutsche Bank, called EMERALD. This note generates modest growth in normal markets and sudden and lasting appreciation in times of excessive market turmoil.

"Pure asset allocation" is the best way to get safety plus return," Miccolis says. "We rebalance portfolios and use a protective structured note that is less costly than using put options."

Others use index annuities sparingly. "We do recommend them for the right people," Graydon Coghlan, a San Diego-based financial planner, says. "I agree with other financial planners about the disadvantages of index annuities. But we are here to help individuals that don't want to take the risk and put money in the stock market."

Evor Vattuone, financial planner with Aspire Capital Management, Walnut Creek, Calif., says he might use index annuities, but very rarely and only for a particular type of client. "We use them when our planning objectives call for a specific fixed income stream and a survivorship risk that can be addressed and guaranteed by the insurance contract and can't be obtained in the open market."